Tags: Carr | VIX | ETP | volatility

Individual Traders Can’t Fully Profit from Market Volatility

By    |   Wednesday, 05 September 2012 07:46 AM

Stock market volatility reached record lows while Wall Street vacationed over the summer.

Everyone knows that volatility will have to go higher at some point because it always does. Although no one knows exactly when volatility will move up, it seems like buying volatility is a guaranteed winning trade.

Unfortunately, there is no way for individuals to buy volatility instruments that will match market volatility.

Volatility is usually considered to be the Chicago Board Options Exchange Volatility Index (VIX), an index that is calculated from the way stock market options trade. There is no way for individuals to buy or sell the VIX, but there are a number of exchange-traded products (ETPs) that are based on the VIX. However, all of them fail to match the moves of the index.

From the August lows, the VIX jumped more than 35 percent. An ETP that offers exposure to short-term moves in the VIX was up 9 percent over that time. A longer-term ETP based on the VIX was up only 6 percent.

There are a number of other ETPs based on the VIX, which also delivered similarly disappointing results. As the VIX declines, these ETPs tend to lose more than the VIX does because of management fees and other expenses.

Individual traders cannot profit as they would expect from volatility. It is possible to win by buying a VIX-related ETP when volatility is low, but the size of the gains will be much lower than the individual hears about for the VIX index.

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Wednesday, 05 September 2012 07:46 AM
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